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October 2011



Ecolab (NYSE: ECL)

October 28, 2011 – Comments (0)

Market Data

Current Price: $55
Market Cap: $12.76 billion
MRY Sales: $6354.5 million
Cash/Debt: $163.2 million/$1106.8 million
Industry/Sector: Specialty Chemicals

Business Description

Ecolab Inc. develops and markets products and services for the hospitality, foodservice, healthcare, and industrial markets on a global scale. Things they produce include: cleaning and sanitizing products and programs, pest elimination, maintenance and repair services. The company reports in three segments: U.S. Cleaning and Sanitizing; U.S. Other Services Segment; and International Segment.

From the 10-K ”We believe that we are the leading supplier of chemical warewashing products and programs to institutions in the United States.” “We believe that Kay is the leading supplier of chemical cleaning and sanitizing products to the QSR market segment and the food retail market segment in the United States.”

This is a solid razor and blade model in that they sign contracts with companies to provide the services, supply the equipment as part of the contract and then sell the consumable cleaners, solutions, etc. that are only compatible with their equipment. In fact the company estimates that 90% to 95% of their sales are recurring in nature. Given the company’s global reach, scale and breadth of product line, not to mention healthy cash flow that helps them achieve R&D goals to develop new products, Ecolab looks like the one to beat in this industry.

•  U.S. Cleaning and Sanitizing: Comprised of six business units including Institutional (largest of segment), Food & Beverage, Kay, Healthcare, Textile Care and Vehicle Care.
•  U.S. Other Services: Comprised of two units including: Pest Elimination and GCS Services.
•  International: Conduct business in countries outside of U.S., close to half of revenues in 2010 were earned internationally. Done through wholly-owned subsidiaries (except Venezuelan JV). In all ECL delivers comprehensive programs and services to foodservice, food and beverage processing, healthcare, and hospitality markets in more than 160 countries.

Who are they selling to?

No customer or distributor constitutes 10% or more of consolidated revenues. Customers include large restaurant chains including McDonald’s, Burger King and Yum! Ecolab controls about 10% of the global $57 billion market.

From 10-K: "Our manufacturing facilities produce chemical products as well as medical devices and equipment for all of our businesses, although the businesses constituting the United States Other Services segment purchase the majority of their products and equipment from outside suppliers. Our chemical production process consists primarily of blending and packaging powders and liquids and casting solids. Our devices and equipment manufacturing operations consist primarily of producing chemical product dispensers and injectors and other mechanical equipment, medical devices and dishwasher racks and related sundries and dish machine refurbishment."

What’s it worth?

As of today the stock trades at a trailing P/E of 26 and EV/EBITDA of 11 versus 10-year averages of 24 and 11.2 respectively and 18.5 times 2010 free cash flow. The company has paid a dividend for 72 consecutive years and currently yields 1.3%. With a payout ratio consistently under 30% the dividend appears quite safe. It’s worth noting too that although customers can certainly sign contracts with new suppliers, this is easier said than done as once equipment is installed it is in there and not so easy to get out. Therefore switching costs can be high. And if ECL is providing the better service and product, then businesses will not have a reason to switch.

It's also worth noting that Ecolab is in the middle of closing the Nalco acquisition. This is an $8.2 billion dollar acquisition that will give Ecolab a bigger market as they will add chemicals and technology used in water treatment, pollution control, energy conservation, oil production and refining, steelmaking, papermaking, mining, and other industrial processes. Nalco’s three segments are: Water Services, Paper Services, and Energy Services. Nalco is the market leader in global water treatment with 18% share.

In running through a preliminary DCF model and adjusting figures to accomodate for the Nalco acquisition I can see shares worth somewhere in the neighborhood of $50-$55. This assumes that the company will be able to grow revenues at an average of around 6.8% annually over the next decade (reasonable based on historical average above 7% as well as the share gains in gloabl water treatment due to acquisition). It also assumes I think relatively modest operating margin assumptions over the course of the decade, a 10% discount rate and 2.5% perpetual along with about $5 billion in debt post-acquisition. Management has made the point as well that after the acquisition closes, they will be refinancing their debt to consolidate and take advantage of historically low rates. This will help raise their coverage ratio, but given the cash the company generates in a given year and market position, the debt is not a great concern at this time.

My personal take is that today it's a little more on the expensive side, but not outrageously so. They just announced earnings and things are going well so the price has moved up a little bit lately. I would love to catch this one when the market pulls back. My belief is that this is a quality company and well-run, so there is a premium there. It's the type of stock that should occupy the portfolio for long period of time given the high returns and dividend. If I ever catch it sub-$50 I will be on it like white on rice. But I would still entertain the idea in the $50-$52 range as well.

Competition and Risks

Ecolab's biggest competitor is Diversey however it generates twice the sales and continues to pick up share on Diversey.

•  They are an acquisitive bunch; it remains to be seen that they will be able to integrate one of such size in Nalco;
•  Raw materials costs: Alkalis, acids, phosphorous materials, silicates and salts, and organic chemicals, including surfactants and solvents. These materials are generally purchased on an annual contract basis from a diverse group of chemical manufacturers. Pesticides used by our Pest Elimination Division are purchased as finished products under contract;
•  Products can fall in the purview of regulation;
•  Just as it’s an advantage, higher switching costs sometimes lead companies to complacency. ECL must constantly strive for this not to happen. Getting a bad reputation can be very difficult to get rid of.

Who’s Managing This Company?

Douglas Baker is CEO since 2004, President since 2002 (also on US Bancorp board), with the company since 1989. Steven Fritze is CFO since 2008; with the company since 1998. Larry Berger is CTO since 2008 and with the company since 2008. Christophe Beck is EVP of Institutional North America since 2008, with company since 2007. Insiders own .31% of the shares outstanding.

A project known as Ecolab Business Solutions (EBS) has been rolled out to implement a common set of practices and processes in European operations; China rollout has started.

I don’t like how general MIP is set on EPS, however it should be noted that in certain instances some executive goals (business unit managers for example) are set on revenue and operating income goals. Other performance based stock awards appear to vest over long-enough time frames to encourage good decision making.

What are some arguments for investing in this company?

•  Also worth noting the Bill and Melinda Gates Foundation recently started building what looks to be a significant position in the company in mid-2010; holdings have almost doubled since then.
•  For the ten-year period from 1/1/01 – 12/31/10 sales have increased 162%; stock price has appreciated 134% versus the S&P 500's 5% decline. Share performance has outperformed the S&P 500 for the seventh consecutive year and nine of the last ten years.
•  The company continues to generate high returns on equity (above 22%) consistently. This should continue to improve as well with Ecolab Business Solutions which will bring international business more in line with each other, improving margins as well.
•  Base level growth comes simply from population growth, particularly in emerging economies, but true the world over. At close to 7 billion today, estimates run from a conservative 7.5 billion to more robust 10.5 billion by 2050. Split the difference and say 9 billion.
•  Its sales force is an asset as well. With extensive training, consistent and frequent customer visits, they are able to keep up with customers’ needs and provide the level of service that satisfies them.
•  This is a Buffett business. High returns on equity, a recurring and necessary product and a moat in scale.

My Foolish takeaway

Bottom line is I like the company and have it on a very short list of stocks that I would like to add to my RSP. I want to review some more earnings calls and give it a chance to settle for a bit. If there is any kind of pullback in the market (and let's face it, it's almost inevitable with the potential catalysts out there including another downgrade and/or the Congressional "super-committee" failing to come to an agreement to work our way out of our tremendous national debt load), I'm sure this one will fall with the rest and I will take advantage.   [more]



September Unemployment Rates By State

October 21, 2011 – Comments (0)

Here we go:  [more]

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